Bitcoin Wallets: What are the differences between them?

Jan 2, 2013

Satoshi Nakamoto first published their paper on Bitcoin back in 2009, but it didn’t reach real mainstream popularity until recently. Only the users who understand the highly technical mechanics of Bitcoin invested their time in the technology during 2009-13 intermission period. In February of 2013 Bitcoin, and soon cryptocurrencies in general, finally entered the public consciousness. Despite being a four year old technology, many of the core features of the Bitcoin protocol were not polished in any capacity, let alone ready for mass public consumption. The Bitcoin wallet is an excellent example of one such component. Since that first popularity explosion, much expertise has gone into designing and refining the Bitcoin wallet. Today we will be taking a look at the differences in functionality of the three types of wallets as well as comparing their security and usefulness. These types of wallets suit users depending on the way people wish to access their funds, as well as who they want to entrust the long-term security of their accounts.

What is a Bitcoin wallet?

For a majority of Bitcoin users, the first cryptocoin interface they encounter is the wallet. Much like the physical wallet you keep in your back pocket, your Bitcoin wallet serves to store currency that you mine, purchase, or receive from others. Your digital wallet functions in a very similar way to its real life counterpart – however,there is one key difference: Cryptocurrencies are exchanged using addresses not unlike email, with the exception that your Bitcoin addresses are generated randomly on your behalf. Your wallet can hold more Bitcoin addresses then you could ever use, and each address functions as a separate place for you to send and receive money. Think of each address as a separate compartment in your wallet, or as the various different bank cards you own that each have their own individual balances. These addresses are where all transactions are directed, whether they’re yours, or run by the companies you use to collectively hold your money.

Offline Wallets

In the beginning of Bitcoin, there were offline wallets. These wallets operate in the “traditional” wallet style – that is, with all of your wallet data stored only locally on your own personal machine and not in need of a constant internet connection. You do need to be on the internet to receive and send your currency, but you don’t always have to be online. Initial Bitcoin commerce wasn’t possible without at least a basic wallet, and the offline wallet was the simplest solution for early adopters to code up and release to the public, including the one Nakamoto published. As such, offline wallet apps are readily available on both the desktop and mobile platforms. It should also be noted that any damage to your wallet data can quickly render it corrupted, which means your keys (and your cash) are unrecoverable without a backup. This limitation drives fear into the heart of many Bitcoin enthusiasts, some of which can barely keep track of their physical keys, let alone their digital ones. As a result, it’s important to keep many copies of your wallet information secure and safely stored away, even if just on a USB drive behind a safe.

Online Wallets

When hosted, or online, wallets entered the scene, they changed the entire Bitcoin wallet paradigm. Instead of keeping all your wallet information stored locally, a sensible online wallet stores an encrypted copy of your wallet data on their servers with a password you choose. When you want to access your wallet, your data is downloaded and decrypted locally. After you have completed your transactions, the hosted wallet uploads your encrypted wallet to back servers the hosted wallet controls. This relieves the user of the responsibility of backing up their wallet as well as “syncing” their wallet across their devices — all while keeping the users keys protected from abuse on the company’s servers by only doing encryption and decryption operations on the “client side”, aka locally on your machine. Online wallets are most popular on web browser centric and mobile devices, but the nature of this type of wallet makes easy access possible on any networked system. IT also ensure you don’t have to run your computer all day as a node to keep up with transaction activity on the Bitcoin network, and can let your provider handle all the trouble. However, if anything were to happen to the company you use to store your currency, then you’d be out of luck unless they offer a backup service to store copies of your wallet offline.

Deterministic Wallets

A third type of wallet exists exclusive of the other two: The deterministic wallet. The previous two types of wallet operate as variations of each other, where the online and offline wallets manage the same wallet data that is located either on your machine or is shifted to someone else’s. On the other hand, the deterministic wallet generates master root key (consumable by humans in the form of a twelve word passphrase) and hands it to the user. The root key is the only information the user is required to keep track of. Once the root key in input, the deterministic wallet uses advanced cryptographic algorithms to derive new private keys, or addresses, from the original root key. Because the wallet is creating new addresses using the same formula with the same initial conditions each time, all addresses are said to be predetermined from the root key. This handy fact allows you the option to store your wallet backup securely in your brain (via memorization) without the need for the key to exist digitally anywhere — all while still being able to access funds in any of the derived addresses. The portability of this system grants deterministic wallets secure interfaces on your desktop, your mobile phone, and your web browser. This of course still depends on you remembering a very unique kind of password that may be difficult to recall, or if written down can pose a security threat.

Which should you choose?

Since the invention of the Bitcoin protocol users and developers alike have worked to shape the function and feel of cryptocoin wallets. Today wallets are more robust, packed full of features, and offer security that we couldn’t imagine during the infancy of Bitcoin. Wallets come in many forms and serve many purposes. We’ll share with you next how most popular wallets available compare, and what you can do to pick the one that suits you.